Introduction to Hedge Replication
Hedge Replication aims to replicate the performance of hedge funds by analyzing their 13F holdings and investing in their best ideas. We track a pool of over 150 best-of-breed hedge funds across the equity long/short, event driven, and concentrated long-only space.
We invest a substantial part of our wealth in our long-only equity strategy, a concentrated, equally-weighted 10 stock portfolio. The portfolio is built around the highest conviction ideas from our proprietary 13F screen, with a qualitative overlay to manage risk. For example, we adjust portfolio beta by balancing the ratio of higher beta vs. lower beta names, as well as between high quality compounders vs. special situations investments. Our aim is to pursue attractive risk-adjusted returns by concentrating the portfolio in a limited number of undervalued companies with catalysts for value creation. We do not hedge our portfolio or make use of derivatives.
What Companies Do we Look For?
In general, the portfolio will comprise of 3 types of companies:
(1) "Franchises" - Businesses with sustainable competitive advantages, high ROIC, limited leverage, and strong management. Intrinsic value is compounding.
(2) "Cyclicals" - Franchise or non-Franchise businesses with cyclicality in EPS. Investment thesis requires a catalyst for non-franchise companies.
(3) "Special Situations" - Spinoffs, M&A, management change, IPOs, technical factors, etc. Catalyst is required.
A Naive Backtest
Below is a simple backtest of our strategy vs. the S&P 500 Index without the qualitative overlay, starting from 14 February 2008. The portfolio is then rebalanced on a quarterly basis, after each filing date (45 days post quarter-end). The portfolio comprises of the ten most frequently held securities across our hedge fund universe.
The naive strategy has outperformed the market over each 12 month period, with a lower beta (0.88 over the whole period).
Feb 08-Feb 09: -30.9% vs. -56.1%
Feb 09-Feb 10: +48.7% vs. +34.0%
Feb 10-Feb 11: +24.1% vs. +18.8%
Feb 11-Feb 12: +7.1% vs. -0.4%
Feb 12-Feb 13: +24.1% vs. +10.8%
Feb 13-Nov 13: +24.0% vs. +16.5%
The Model's Picks for the Previous Quarter
For the most recent period (14 Aug-14 Nov), the portfolio returned +8.1%, vs. a rise of +5.9% for the S&P 500 Index. Below was the portfolio composition and constituent returns:
- American International Group Inc (NYSE:AIG): +3%
- Charter Communications, Inc. (NASDAQ:CHTR): +3%
- Google Inc (NASDAQ:GOOG): +19%
- Liberty Global Plc (NASDAQ:LBTYK): +5%
- Liberty Global Plc (NASDAQ:LBTYA): +5%
- Mastercard Inc (NYSE:MA): +18%
- Priceline.com Inc (PCLN): +21%
- Realogy Holdings (NYSE:RLGY): +4%
- TransDigm Group Incorporated (NYSE:TDG): +5%
- Twenty-First Century Fox Inc (NASDAQ:FOXA): +6%
Our Top Picks for the Current Quarter
We are pleased to publish the holdings for our portfolio at the most recent rebalancing date.
- American International Group Inc : existing holding
- Apple Inc (NASDAQ:AAPL): new holding
- Charter Communications, Inc. : existing holding
- CBS Corporation (NYSE:CBS): new holding
- Dollar General Corp. (NYSE:DG): new holding
- Facebook Inc. (NASDAQ:FB): new holding
- Microsoft Corporation (NASDAQ:MSFT): new holding
- TransDigm Group Incorporated : existing holding
- Twenty-First Century Fox Inc : existing holding
- United Parcel Service, Inc (NYSE:UPS): new holding
We will review the performance of our portfolio at the next rebalancing date in February 2014.
Disclosure: I am long AAPL, AIG, CBS, CHTR, DG, FB, FOXA, MSFT, TDG, UPS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.